Sunday, November 4, 2012

Microfinance: Something Sachs and Easterly Can Agree On?

In this post, I will explore arguably the biggest new idea in poverty-reduction – microfinance – which has received considerable attention, investment and scrutiny in the past few years as it expands across the globe. I would like to evaluate the impact and overall philosophy of microfinance using Easterly’s straightforward approach. I will discuss how the burgeoning microfinance movement has both searching and planning implications, showing why Easterly’s dualistic view of development programs may be overly simplistic.

In one of his anecdotal snapshots, Easterly seems to endorse the microfinance movement, insofar as it was conceived by Mohammad Yunus in true Searcher fashion. Yunus identified a very specific, homegrown need, and went about formulating a way that local lending markets could fulfill that need. Since this need – financial access to micro-loans to smooth income and consumption - is arguably universal amongst the world’s poor, we have seen somewhat of a microfinance revolution across the world since its humble inception in rural Bangladesh. This expansion beyond its specific context, coupled with some concerns over its measurable impact, would likely cause Easterly to soften his praise.

Microfinance is very much a bottom-up approach that helps poor people help themselves. Shifting the approach from large macro-inputs to a very real, micro level about money (in the form of micro-loans) that can actually be translated into really “outputs” such as education, health, increased income from businesses, etc. It is not a Big Plan instituted across the board with cookie-cutter policies; rather it tends to vary with each context, and it is local individuals taking on the risk. However, as it grows in scale, it is ever in danger of becoming more streamlined, and seen as a necessary part of the overall development package through the belief that access to financial instruments (such as bank-operated savings and loans) is a fundamental need that must be filled in order for people to pull themselves out of poverty.

It has clearly brought about some positive results, particularly the empowering and women and a paradigm-shifting realization that poor people are “bankable” and are not a huge credit risk (they have shown very impressive levels of repayment). However, in order to pass Easterly’s development muster, programs must stand up to rigorous statistical evaluation and be specifically aimed at a need within a small, specific context. A study by Jonathan Morduch, the modern superstar of microfinance impact, of the flagship microfinance programs from the Grameen bank in Bangladesh shows that households with access to micro-loans do not have higher consumption levels than others, and their children are no more likely to be in school. Experiments showed that microcredit only nudged up the rate of new business-formation from 5% of households to 7%. Microloans are most often used for something else, such as financing the purchase of consumer durables or repaying debts to moneylenders. From an anecdotal perspective, I can say that I certainly saw that “dark side” of Microfinance through my fieldwork in Peru, a hot bed for microfinance. These poor, undereducated Peruvians were no better at handling constant, excessive debt than your average American. The proliferation of easy credit to those who are truly under qualified is more dangerous than no credit at all. This is not just a truism for the developing world, look no further than the sup-prime mortgage crisis to see how aggressive banks can prey on those searching for credit that is cheap and seems too good to be true (see link to below to Strangio’s critique of microfinance). I certainly believe that microfinance has created an artificially high demand for credit in poor populations, using promotions and interest rates to lure poor people into dangerous levels of debt.

One might expect, however, that microfinance banks would not have the same profit-motive as the greedy mortgage-banks in America, and this leads us to one of the biggest debates in microfinance today, should MFI’s be profit-seeking or should they operate from donations alone?

Many believe that profit is essential for the sustainability of these institutions. However, there are some very valid concerns over the expansion of the microfinance sector. Easterly might argue that this effort to make a large, formal sector of banks that serve poor customers is too much of a Big Plan based on some vague ideal about the universal access to credit, savings, insurance for all. Certainly, the expansion of these banks to new “unbanked” areas and populations would require a large influx of foreign investment/aid/donations to fund these banks. Bill and Melinda Gates have already given millions to initiatives that support microfinance (I have actually been the beneficiary of some of these funds myself). However, it is important to consider what might happen if they banks expand without the proper government regulations and oversight, particularly given that their customers are particularly vulnerable.  If the US has trouble regulating its banks, one could imagine these issues would be even worse in the third world. Also, giving loans to poor people to help them achieve their goals is noble, but the unfortunate reality is that they need the training and education to learn how to pay it back responsibly and there will always be banks looking for an opportunity to take advantage of that need in the market.

Easterly has written a little bit about microfinance, remarking that it tends to be overhyped and that it achieves the best results in 1) small scale application and 2) specific contexts. He is wary of it being converted into a Big Plan with excessive targets and goals that it cannot truly meet. However, it would seem that his love for markets, as ultimate conduits of feedback and coordination, might sway him to support the unleashing of MFI’s so long as their services are ultimately provided positive outcomes for the world’s poor.

Microfinance is one of the few things that Sachs and Easterly agree on, and this is perhaps because both of their approaches have become overly dogmatic. Microfinance has its origins in a grassroots Searching approach, yet is sits precariously on the edge of a mainstream Planning takeover that would greatly spread it to all the unbanked corners of the developing world (as wells as poor areas within developed countries). Therefore, to beast reap the benefits and minimize the costs of microfinance, some important reforms must be put in place before it is unequivocally embraced and codified like the rest of the Millennium Development goals. Based on the debates, we should at minimum assess the following:
1. More rigorous impact evaluations to see what works in different environments.
2. Avoid the pitfalls of Planning approach, such as a target of making every rural village “banked” by a certain year, also be wary of streamlined MFI’s and practices across different countries and regions.
3. Come to consensus on the profit-motive of MFI’s, understand the crucial role of regulations/oversight in the feasibility of this option


Murdoch’s Impact Study:

Easterly on Microfinance:

Strangio on Microfinance Shortcomings:

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